Sponsored Article in Australian Financial Review
Oct 29, 2024
A combination of strong global trends, robust structural protections, and booming immigration has led to a significant increase in interest in commercial real estate debt (CRED) in Australia.
As traditional investment avenues grapple with economic pressures and market volatility, CRED has emerged as a valuable asset class, offering both stability and enhanced returns, which has been increasingly recognised in recent times.
The rising demand for residential and commercial properties, fuelled by high immigration rates and a resilient local market, has further strengthened the appeal of CRED.
This growing interest reflects the asset class’s capacity to deliver dependable income and capital protection in an increasingly unpredictable financial environment.
Bruce Wan, head of research for MaxCap Group, says that the shift from equities to credit is largely due to “better risk-adjusted returns”.
Wan says that traditional asset classes have faced challenges, with both stocks and bonds underperforming at times. “Investors are looking to private credit for more resilient returns,” Wan says.
The case for CRED is further bolstered by its structural protections, Wan says.
“Credit buffers are still holding up and protecting credit investors,” Wan says. This stability is particularly attractive in an environment where residential property prices remain resilient despite economic fluctuations.”
Global trends also play a role in the rising interest in CRED.
Robert Hattersley, group head of capital at MaxCap Group, says that pension funds, insurance groups, and sovereign wealth funds are increasingly allocating resources to credit.
“Capital is moving from public to private markets, especially in the developed world,” says Hattersley. Australia’s transparency and safety make it a preferred destination for such investments.
Liquidity is another key factor driving the popularity of commercial real estate debt. Unlike real assets, which can be less liquid, CRED offers regular cashflow. “Real estate debt is often self-liquidating, providing more liquidity than real assets,” Hattersley says. This constant turnover of loans ensures that investors can access their funds more easily.
Moreover, CRED can provide a natural hedge against inflation. With rising interest rates, returns on private credit can increase, offering a buffer against inflationary pressures. “Private credit can be on the other side benefitting from high inflation and ratesdrive,” Wan says. The shift to floating rate loans further enhances this protective feature, aligning returns with rising rates.
Investors are also drawn to CRED for its role in portfolio diversification. In recent years, traditional diversification strategies have faltered, with both equities and bonds experiencing simultaneous downturns. “Your typical stock-bond portfolio just didn’t work in the way that you expected,” Wan says. In contrast, CRED offers diversification benefits due to its lowly correlated with other major asset classes.
Assessing risk and resilience
Assessing risk is crucial for investors considering CRED. Hattersley stresses the importance of a manager’s track record and capability.
“Investors should look for managers with a long and successful track record,” he says.
According to Wan, local real estate assets have shown remarkable stability compared to overseas markets. “The value of our real estate assets is far more resilient than what we see overseas,” he says.
While the sector faces challenges, such as construction risks, these can be managed with the right expertise. Wan stresses the importance of specialised skills and resources in navigating these complexities. “Having the right skills and resources are vital to manage risks,” he says.
By leveraging CRED, investors can achieve a balance between stability and growth, ensuring their portfolios are well-positioned to weather economic uncertainties, he says.
Immigration and unusual tailwinds
Meanwhile, Hattersley says that immigration is a major driver of demand in housing, contributing to the significant undersupply in the Australian market.
“Immigration is a real positive for commercial real estate debt,” Hattersley says. “It’s underpinning value for residential, which plays into the hands of commercial real estate debt when we’re lending to developers in the living sector.
“This includes both developers of residential-for-sale and for rent, as well as those funding the purpose-built student accommodation sector. So all areas of living benefit from strong immigration, which enhances returns for real estate credit.”
Wan highlights an unusual convergence of positive factors in the sector.
“We’re seeing a very unusual mix of tailwinds in this sector,” Wan says. “High migration is doing us a favour in a way we didn’t expect.
“Ordinarily, high mortgage rates would lead to falling house prices, but that’s not what we’re seeing this cycle.
“Because of immigration and strong housing demand, we’re experiencing higher mortgage rates alongside rising dwelling prices. This strength of migration benefits the private credit space with higher returns and better collateral values, a combination of factors we haven’t seen in previous cycles.”
Craig Brooke, CEO of financial services firm KeyInvest, says he and his clients use commercial real estate debt (CRED) for diversification in their portfolios.
“Portfolio building needs a level of diversification,” he explains. Unlike equities, which are often at the bottom of the capital stack, CRED offers a different risk-adjusted return profile. “The first mortgage investment options offered through CRED provide returns that are superior to this,” he adds.
Diversification appeal
Brooke highlights the strong performance of CRED investments compared to other asset classes. “They have performed incredibly well,” he says, acknowledging concerns about liquidity but noting that “there is a sufficient premium for the level of illiquidity on offer, and most mortgages remain short duration in nature in any case.”
By diversifying with CRED, clients can balance their return profiles and invest in property without associated transaction costs.
“While you don’t see a capital gain that you may when investing in property direct, you do experience a very stable performance of income every month,” Brooke says.
The short duration nature of these investments makes them advantageous, offering capital protection and diversification across a pool of senior debt.